Author Topic: Time for some proper due diligence/ independent auditing in our communities  (Read 229669 times)

Offline aygart

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Same thing. I have a zero-tolerance policy for loads and 12b1 fees. ER needs to be reasonable as well. We're in 2023 now.

All of those are a fee for a service that hopefully is actually received. Without them the hurdles can be too high for some smaller investors. They also help pay for the administrative costs of retirement programs.
Feelings don't care about your facts

Offline knowitall

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To put this in layman’s terms for those who aren’t following, say a guy is purchasing an apartment building for 20 million. It’s a couple of years ago so he manages to get a loan for 16 million and has to raise 4 million from a bunch of investors (80% LTV- loan to value.)

He takes an acquisition fee of $400,000 (numbers are not exact) which is 2% of the 20 million purchase price and pockets it when the deal closes. This means that only 3.6 million of the investors money went into the property, and they are down 10% on their investment on day one.
Good explanation.
In reality there are many other costs to transact, such as legal, debt brokers, title, environmental, other due diligence costs, etc. There are also fees to sell, such as sales brokers. This means that if you buy a property for 20M and sell it 3 years later for 22M, there likely is little to no profit on the sale that reaches investors. (Hopefully they got some cashflow during the hold)

Offline aygart

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Either way, assuming no foul play involved, what due diligence would have helped the investors, (if its a healthy property, cash-flowing, 1031-ing, refi-ing again n again, getting monthly distributions, getting some capital back, keep the good times rolling....) -

I am hearing now that an investor's audit found him skimming off for himself. I think the properties are okay and just need new management. Investors have been getting returns.
Feelings don't care about your facts

Offline elimmm

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I am hearing now that an investor's audit found him skimming off for himself. I think the properties are okay and just need new management. Investors have been getting returns.
investors have been getting the same returns, in todays market? Does that mean he had so much extra cashflow until rates went up, and that's what he was skimming? (never mind who HE is, lets keep this nameless, as there are more than one that ppl are talking about)

Offline knowitall

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investors have been getting the same returns, in todays market? Does that mean he had so much extra cashflow until rates went up, and that's what he was skimming? (never mind who HE is, lets keep this nameless, as there are more than one that ppl are talking about)
The pros usually avoided floating rate bridge debt, unless it was the type of deal that really called for it.

I know of many deals doing just fine right now.

Offline Yakov15

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To put this in layman’s terms for those who aren’t following, say a guy is purchasing an apartment building for 20 million. It’s a couple of years ago so he manages to get a loan for 16 million and has to raise 4 million from a bunch of investors (80% LTV- loan to value.)

He takes an acquisition fee of $400,000 (numbers are not exact) which is 2% of the 20 million purchase price and pockets it when the deal closes. The bank is not paying any of the acquisition fee; they expect the full 16 million back. The investors are paying the entire $400,000. This means that only 3.6 million of the investors money went into the property, and they are down 10% on their investment on day one. The acquisition fee is stated as 2% but it is actually a 10% fee, a hefty price of entry.
Some of these sponsors can be working on deals for 2 years until they close on one. Then they have to hustle to raise the money. And sometimes there’s a split if there’s more than one sponsor. The acquisition fee is what makes the hustle worth it and affordable to the average sponsor. Would you rather just have the big players making deals with minimum $1 million buy-in, and still take a large chunk when there is a capital event?

Offline aygart

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investors have been getting the same returns, in todays market? Does that mean he had so much extra cashflow until rates went up, and that's what he was skimming? (never mind who HE is, lets keep this nameless, as there are more than one that ppl are talking about)

If the deal was protected against rising rates and had good fundamentals then why shouldn't it?
Feelings don't care about your facts

Offline aygart

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Some of these sponsors can be working on deals for 2 years until they close on one. Then they have to hustle to raise the money. And sometimes there’s a split if there’s more than one sponsor. The acquisition fee is what makes the hustle worth it and affordable to the average sponsor. Would you rather just have the big players making deals with minimum $1 million buy-in, and still take a large chunk when there is a capital event?

Yes there is a place for reasonable AFs. Somehow the sydicators with a deal a month also have the highest AFs.
Feelings don't care about your facts

Online liosac

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Good explanation.
In reality there are many other costs to transact, such as legal, debt brokers, title, environmental, other due diligence costs, etc. There are also fees to sell, such as sales brokers. This means that if you buy a property for 20M and sell it 3 years later for 22M, there likely is little to no profit on the sale that reaches investors. (Hopefully they got some cashflow during the hold)
In today environment you are also likely going into a deal with negative leverage. This means that the bank is ostensibly earning a higher rate of return, for far less risk, than the investor. The leverage is actually negatively impacting your return. There had better be a good value play to justify all of the above other than “RE always goes up because the next guy is willing to pay even more.”

Offline Fish Tank

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In reality there are many other costs to transact, such as legal, debt brokers, title, environmental, other due diligence costs, etc. There are also fees to sell, such as sales brokers.
Those fees don't get deducted from the $400k acquisition fee. They are listed as a separate line item.

Offline Moshe123

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Sometimes the medicine is almost as bad as the disease. It might be needed very much, but the ramifications are enormous. I'm in the construction line and high construction loans interest rates has put new starts to sleep.

Offline yuneeq

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Those fees don't get deducted from the $400k acquisition fee. They are listed as a separate line item.

That's true only for deals that close
Visibly Jewish

Offline chevron

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To put this in layman’s terms for those who aren’t following, say a guy is purchasing an apartment building for 20 million. It’s a couple of years ago so he manages to get a loan for 16 million and has to raise 4 million from a bunch of investors (80% LTV- loan to value.)

He takes an acquisition fee of $400,000 (numbers are not exact) which is 2% of the 20 million purchase price and pockets it when the deal closes. The bank is not paying any of the acquisition fee; they expect the full 16 million back. The investors are paying the entire $400,000. This means that only 3.6 million of the investors money went into the property, and they are down 10% on their investment on day one. The acquisition fee is stated as 2% but it is actually a 10% fee, a hefty price of entry.

I'm no expert but if you did those numbers, you'd need to be raising 4.45 million to take off 2% otherwise you'd have 19.6 after taking 400k

Offline Afrages6

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It’s great that Ira and other guys in the industry acknowledge the dynamic. We need the clueless heimishe guy putting in his yerusha or his retirement saving to be aware as well.
Righteous from Ira who’s trying to make investing in real estate extremely easy through Gparency.

Offline knowitall

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I'm no expert but if you did those numbers, you'd need to be raising 4.45 million to take off 2% otherwise you'd have 19.6 after taking 400k
Don’t nitpick the numbers.
On a 20M deal with 16M coming from the bank, the equity raise would usually be 5~M, as there are many costs and reserves besides the 400k acq fee.

Offline Fish Tank

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I'm no expert but if you did those numbers, you'd need to be raising 4.45 million to take off 2% otherwise you'd have 19.6 after taking 400k
. . .Not if the syndicator puts his commission into the deal.

Online liosac

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Don’t nitpick the numbers.
On a 20M deal with 16M coming from the bank, the equity raise would usually be 5~M, as there are many costs and reserves besides the 400k acq fee.
Of course. That’s why I wrote numbers are not exact. It was just a rough illustration of the effect leverage has on the acquisition fees in layman’s terms.

Online liosac

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Some of these sponsors can be working on deals for 2 years until they close on one. Then they have to hustle to raise the money. And sometimes there’s a split if there’s more than one sponsor. The acquisition fee is what makes the hustle worth it and affordable to the average sponsor. Would you rather just have the big players making deals with minimum $1 million buy-in, and still take a large chunk when there is a capital event?
No one is saying he isn’t doing any work for his fee. The fact remains that the LP is underwater by a large percent from day one and it creates diverging interests between the GP and LPs to boot, as discussed extensively in the LinkedIn thread cited above. The are other ways of structuring the deal structures that would mitigate this. Requiring serious skin in the game as apparently was common until recently would also change the dynamic.

Offline elimmm

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In today environment you are also likely going into a deal with negative leverage. This means that the bank is ostensibly earning a higher rate of return, for far less risk, than the investor. The leverage is actually negatively impacting your return.
can u elaborate with sample numbers, for the layman, as u did with previously?

Online liosac

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can u elaborate with sample numbers, for the layman, as u did with previously?
Just really briefly the cap rate is a measure of yearly net operating income as a percentage of the market value of the property. If you buy a property valued at $1 million for cash and the property is generating $100,000 of operating income each year that is a cap rate of 10 or 10% of the market value. As prices have gone up in recent years, cap rates have gone way down. Meaning people are paying more for properties that are yielding less.

It was not uncommon to have cap rates at around 3.5 which means that the property is yielding net operating income of around 3.5% of the market value of the property annually. Of course few people will accept a 3.5% return on their money. However, there is often an expectation that rents can be raised especially if improvements are made to the property so what looks like a 3.5 cap is anticipated by the investor to eventually produce a higher yield which will also push up the value of the property.

For example, if a $10 million property was producing net operating income of $350,000 or a 3.5 cap and you can raise the income to $700,000 over a few years, as long as cap rates remain at 3.5 that property would now be worth around $20 million. Additionally, cap rates were actually coming down over much of the last decade as prices shot up, which increased the value of the property, even if income stayed the same. This was largely a function of interest rates continually going lower for reasons I’ll explain.

If you could borrow 80% of the purchase price of a 10 million dollar property at 2 1/2% then you are leveraging the cash you are putting in because the 8 million you are borrowing at 2.5% is yielding 3.5% so that magnifies the return on the 2 million cash portion of your investment to far more than 3.5% (this is a simplification ignoring many other expenses and factors.)

Then they were also the speculators who bought simply because they thought someone else down the road will pay a higher price much like happens with momentum stocks, and this was also a factor in the prices going sky high.

Fast forward a few years and that 3.5 cap property now requires a loan at 7%. This means that all things being equal every dollar of the 8 million that you are borrowing at 7% is only yielding 3.5%. That is actually hurting your return. Your cash portion is yielding 3.5% but your loan portion is losing money and  could very well  be wiping out any yield from the cash portion. To  buy the property at that price you had better you have a very good game plan or unusual opportunity, such as rents that are way below market or some other factor that will make it worthwhile despite the lousy numbers . In general, the higher interest rates are going to naturally put pressure on the cap rates for the reasons above.


To put things another way the bank is getting 7% on its money with relatively little risk. They have first dibs on the property in the event of a default. Granted, they may not recover the entire value of the loan , but because they’re only lending out a percentage of the full value, even if valuations go down, they stand to recoup most of their money, even if the investment is a flop. The investor on the other hand is taking the risk of losing all his capital and only getting a yield of 3.5% on his money, even less when considering the negative leverage. In theory, the greater the risk that is taken the larger  the return ought to be , so something is off; the market is not where it should be and prices need to come down significantly (cap rates need to rise.) there will always be exceptions and niche opportunities but in general the numbers out there today do not support current market valuations, and something is going to give.
 
« Last Edit: May 31, 2023, 11:01:05 AM by liosac »